The EU ETS: Over-allocation or Abatement? A. Denny Ellerman & Barbara Buchner MIT and IEA Workshop on the Evaluation of the EU ETS, 19-20 April 2007, Paris Caisse des Dépôts OECD/IEA 2007
Some background issues Emissions will never exactly equal the cap Especially with intra-period banking/borrowing A constraining cap will always result in long and short positions among installations Reasons for being long/short : The reason that motivates trading: differences in the marginal cost of abatement Uncertainty (of economic activity, weather or any other factor affecting emissions) Deliberate over- or under-allocation
Aggregate EU25 position, 2005: Sum of shorts, longs, and net Sum of Shorts 180.4 Mt 9.0% Net 79.3 Mt 4.0% Sum of Longs 259.6 Mt 13.0% -300-200 -100 0 100 200 300 Million tons-co 2 /EUAs
Short & long positions by Member State, 2005 Poland Czech Lithuania Slovakia Hungary Estonia Latvia Slovenia Germany France Finland Denmark Netherlands Sweden Belgium Luxembour Portugal Greece Austria Ireland Italy Spain UK -55-45 -35-25 -15-5 5 15 25 35 45 EE 8 EU 15 MtCO2 Net Short Net Long Gross Short Gross Long
Short & long positions by sector, EU25, 2005 MtCO 2-160 -120-80 -40 0 40 80 120 Power and Heat U/I Others Iron, Steel & Coke Cement & Lime Refineries Pulp & Paper Glass Ceramics, Bricks & Tiles Net Short Net Long Gross Short Gross Long
A breakdown of positions by major sectors & regions EU15 Power&Heat EU15 Industry SHORT LONG EE8 Power&Heat EE8 Industry -200-150 -100-50 0 50 100 150 MEUAs Net Short Gross Short Net Long Gross Long
An indicator of over-allocation: The Net Long Ratio = If net position is The Net Long Ratio Net Long Gross Long relatively low: no (obvious) over-allocation Shorts offset most of long positions high, implying few or no shorts and a cap that is higher than the counterfactual: strong indication of over-allocation
35% Distribution of EUAs by Member State Net Ratios % of EU25 Allocation 30% 25% 20% 15% UK Ireland Spain Italy Austria Germany Sweden Holland France Hungary Slovenia Poland Czech Slovakia Finland Denmark Baltics Luxembourg 10% 5% Greece Portugal Belgium 0% -1 to -.8 -.8 to -.6 -.6 to -.4 -.4 to -.2 -.2 to 0 0 to.2.2 to.4.4 to.6.6 to.85.85 to 1.0 INTERNATIONAL Difficulty of ENERGY choosing AGENCY Base the right Purchase AGENCE "Sold" threshold INTERNATIONALE DE L ENERGIE
Summary on over-allocation At least 71% of allowances in 11 MSs without evident over-allocation Presumed over-allocation: In 12 MSs with 29% of allowances of which 5.4% are surplus In industrial sectors with 42% of allowances of which 5.6% are surplus But not necessary complete indicator of overall length of EU ETS: some length is due to abatement Maximum over-allocation 100 MEUAs
Now, to abatement How do 2005 emissions compare to historical emissions, not allowance totals? Only historical data is that for baselines for 1 st period allocation Varying dates, but all centered on 2001-03 Potential bias (data collection process) Also, some problems of comparability For now, a proxy for the counterfactual
2005 emissions, base period emissions & total allowances: a regional breakup 2.200 2.000 1.800-3.4% - 2.4% 1.600 Million metric tons CO 2 1.400 1.200 1.000 800 600-7.8% 400 200 EU-23 EU-15 EU-8 0 INTERNATIONAL Baseline Allowances ENERGY Emissions AGENCY EU-23 EU-23 EU-23 Baseline EU-15 AGENCE Emissions INTERNATIONALE Baseline Allowances DE L ENERGIE Emissions Allowances EU-15 EU-15 EU-8 EU-8 EU-8
120 EU 23 GDP growth, 2002-2006 115 EE 8 100 = 2002 110 105 EU 23 EU 15 100 95 90 2002 2003 2004 2005
110 Indicators of economic activity in the EU25, 2002-2006 2006 108 106 104 102 100 Production & distribution of electricity Total industry 2005 Volume index of production; average 2002=100 98 96 94 2002m01 2002m04 2002m07 2002m10 2003m01 2003m04 2003m07 2003m10 2004m01 2004m04 2004m07 2004m10 2005m01 2005m04 2005m07 2005m10 2006m01 2006m04 2006m07
112 Indicators of economic activity in the EU25, 2002-2006 2006 110 108 2005 106 104 102 100 98 96 94 2002m01 2002m04 2002m07 2002m10 2003m01 2003m04 2003m07 2003m10 2004m01 2004m04 2004m07 2004m10 2005m01 2005m04 2005m07 2005m10 2006m01 2006m04 2006m07 INTERNATIONAL Pulp & paper ENERGY AGENCY Glass, bricks, tiles, AGENCE ceramics INTERNATIONALE Cement DE Iron L ENERGIE & steel Volume index of production; average 2002=100
Trends in Real GDP, CO 2 emissions, and CO 2 intensity Annual changes in percent 1995-2000 2000-2004 Real GDP +2.9% +1.8% EU23 CO 2 Emissions +0.1% +1.0% CO 2 Intensity -2.7% -0.8% Real GDP +2.8% +1.6% EU15 CO 2 Emissions +0.4% +1.1% CO 2 Intensity -2.3% -0.5% Real GDP +4.3% +3.6% EE8 CO 2 Emissions -1.8% +0.2% CO 2 Intensity -5.8% -3.3% Slowing in rate of decline in CO 2 intensity since 2000
A high level abatement estimate 2005 counterfactual higher due to Economic growth: EU GDP growth ~ 2% p.a. Higher than expected natural gas and oil prices Carbon intensity improvement has slowed from about 2% in 1990s to -1% since 2000 Implies (at least) +1% growth in CO 2 emissions 2005 verified emissions: about 3% lower than baseline emissions ( 2002?) Implies about 6% abatement 100 MtCO 2 But: many uncertainties from poor data and gross methods
2,200 2,150 2,100 Summarising : an illustrative explanation Theoretical Cap 1% p.a. Counterfactual Over- Allocation Million tons CO 2 2,050 2,000 1,950 Potential Bias in Baseline Data 2005 Allowances 2005 Verified Emissions Abatement 1,900 1,850 1,800 Baseline Emissions The 2005 Situation 1 2
Summary on abatement The basic case for abatement A significant positive price is being incurred Rising real output Emissions are lower than historical levels (even after allowing for plausible bias) Serious work on estimating abatement has yet to be done (baseline bias) A high level estimate would suggest around a maximum of ~150 Mt (but probably too much ); depends on bias, understatement of 2005 VE Over-estimation of CO 2 emissions? Under-estimation of abatement?
Some evidence on changes in technology ČEZ (largest electricity producer in Czech Republic) Reacted to EU ETS; adapted behavior through Dispatching of capacities based on electricity and CO 2 prices Dispatching of power plants adapted to CO 2 (emission factors) Increased focus on availability of nuclear and renewable capacities Increased focus on plant efficiency and CO 2 emissions measurement Non-production of electricity at coal power plants & improvement in electricity production efficiency emission factor at its historic minimum in 2005: 2004-05 emissions saving of 1.48 MtCO 2 Profits from sale of saved EUAs
Some evidence on changes in technology Fortis bank: Fuel switching in the EU power sector EUR / tonco 2 1,000 upper band switch from 40% coal to 48% gas 100 coal-to-gas switch range EUA price, first contract if EUA price is above switch band > utilities prefer gas 10 lower band switch from 36% coal to 55% gas below switch band > utilities prefer coal 1 Jan 05 Apr 05 Jul 05 Oct 05 Jan 06 Apr 06 Jul 06 Oct 06 Jan 07 1 st observation: without CO 2 valuation (EUA at 0/tCO 2 ) no fuel switching; all utilities would have constantly preferred coal over gas 2 nd observation: CO 2 valuation gave a clear incentive for utilities to switch from coal to gas from March 2005 until October 2005
Some evidence on changes in technology Fortis bank: Based on this information: simulation of EU25 power sector during 2005 Case ETS CO 2 valuation (daily market price) Case no ETS without CO2 valuation ( 0/tCO 2 ) Conclusion: without EU ETS, electricity-related emissions would have been about 100 Mt higher than in 2005 Emission reductions of ~ 100MtCO 2 emissions in EU power sector throughout 2005 due to EU ETS CO 2 value taken into account in other sectors
Some evidence on changes in technology Point Carbon: 2005 surplus mainly due to combination of generous allocation & internal abatement/efficiency improvements Empirical evidence for some site-specific reductions (increased energy efficiency, own bio-fuel based power production; permanent/temporary closure) Most striking result form annual carbon Market Survey: significant level of internal abatement initiated should be visible in 2007/2008
Some evidence on changes in technology
Bottom line Almost certainly both over-allocation and abatement Exact magnitude hard to pin down to due poor data and inherent difficulties However, a long position in not a per se indicator of over-allocation: Notwithstanding some 1st period over-allocation (and the lower price), not to mention other problems, the evidence suggests that the EU ETS did reduce CO2 emissions